Fed meeting starts today, but chances of action look slim

WASHINGTON -- Many investors and economists expect the Federal Reserve to take some new step to try to energize the troubled U.S. economy.

The question is whether it will do so Wednesday, after its two-day policy meeting ends.

Probably not, many economists say.

The U.S. economy grew at an annual rate of just 1.5% from April through June, less than the 2% rate in the first quarter. But many analysts say the economy hasn't slowed enough to compel the Fed to announce further help immediately.

Fed officials have signaled their concern about weakening job growth and consumer spending, which have brought the economy closer to a standstill. And Chairman Ben Bernanke has said the Fed is prepared to take further action if unemployment stays high.

What that action might be isn't clear. The Fed has already pursued two rounds of purchases of Treasury bonds and mortgage-backed securities to pump cash into the economy, cut long-term interest rates and encourage borrowing and spending. These programs are called quantitative easing.

The Fed has also extended a program called Operation Twist. Under this program, the Fed sells short-term Treasurys and buys longer-term Treasurys to lower long-term rates.

"I think they are inching towards another round of quantitative easing, but I am not convinced they will get there at this meeting," says Paul Edelstein, director of financial economics at IHS Global Economics.

The Fed meeting is one of three big events this week that investors and economists are watching closely. The European Central Bank meets Thursday, and the U.S. Labor Department releases its July jobs report on Friday.

Markets surged last week after ECB President Mario Draghi said last Thursday that the central bank would do "whatever it takes" to preserve the euro. Over the following days, the leaders of Germany, France and Italy also said they would do all they can to protect the 17-country currency union. The comments raised expectations that the ECB might step in to buy Spanish and perhaps Italian government bonds to lower those countries' borrowing costs.

Even if the Fed did act, few believe that further lowering long-term rates would provide much benefit to the U.S. economy. Most businesses and consumers who aren't borrowing now aren't likely to change their minds if rates slip a bit more.

The yield on the benchmark 10-year Treasury note is already just above its record low of 1.39%, which it touched last week. The national average rate for a new-car loan barely tops 3%. And the average on a 30-year fixed-rate mortgage fell below 3.5% last week for the first time on records dating back 60 years.

If the Fed doesn't announce any new steps this week, most economists expect it to do so after its next policy meeting in September. By then, the Fed will have received more data on the economy's health, including how much hiring occurred in July and August. Bernanke will also have had more time to build support for further bond buying - a move that isn't embraced by everyone on the Fed's policy committee.

Some regional Fed bank presidents have expressed concern that expanding the Fed's investment portfolio beyond its current record $2.9 trillion to try to lower rates more would heighten the risk of high inflation later.

"Various Fed officials have made it pretty clear they want to do something, but they still have a lot of discussion to go through before they get to a decision," says Diane Swonk, chief economist at Mesirow Financial in Chicago. "How do you get the biggest bang for the dollar when the ammunition you have left is limited?"

Some analysts have also suggested that the Fed might be reluctant to act aggressively as the November presidential election nears, out of concern it could be seen as trying to affect the vote.

If the Fed does announce further bond buying, some believe purchases might be divided between Treasurys and mortgage-backed securities. Though at record lows, mortgage rates are still higher than rates on some other loans. Further declines in those rates could help fuel home sales.

Bernanke has sounded most concerned about unemployment. The reports on unemployment for July and August will help show whether the weak job creation this spring is persisting or whether employers have stepped up hiring.

As U.S. hiring as declined, so has consumer and business confidence. Worries have also intensified about Europe's debt crisis and whether the U.S. economy will fall off a "fiscal cliff" at the end of the year. That's when tax increases and deep spending cuts will take effect unless Congress reaches a budget deal. If there is no deal, a recession could follow, Bernanke has warned.

Bernanke has noted that further bond purchases aren't the Fed's only option if it decides to do more. The Fed might choose instead, for example, to extend the timetable for keeping short-term interest rates at record lows beyond its target of late 2014. The Fed cut its benchmark federal funds rate to near zero in December 2008 and has left it there since then.

Some economists say an adjustment of the Fed's target date for any rate increase is also possible as an interim step before further bond buying.

Paul Dales, senior economist at Capital Economics, said he sees a Fed decision to launch a new bond buying program as a 50-50 prospect between now and the end of 2012.